The facts about liquidation
It is generally less complicated to wind up the business of a sole trader (who has declared “bankruptcy”) than to wind up a business run through other structures, for which the terms used would be to “go into administration” and “liquidation”. A sole trader is also less complicated to wind up because the principal of the business is also personally responsible for all debts and liabilities accrued by the business. To wind up a business, a trustee is appointed (either by yourself or by your creditors) to conclude all current contracts, sell remaining stock and other assets, pay outstanding debts and creditors, and notify all concerned (the bank, customers, suppliers).
For any business with an ABN, the Tax Office also says you need to notify it that you have ceased trading within 28 days of doing so, and also to cancel registration for GST, if applicable, within 21 days of cessation of trading. You can keep and re-activate the ABN if things pick up for you in the future (remember, even Donald Trump was bankrupt in 1992). However as long as you keep the ABN active, you will still be expected to lodge activity statements.
Voluntary administration is where a company’s directors hand over the business to a professional administrator to decide on the best plan of action.
If your company can’t pay its debts and is insolvent, voluntary administration and liquidation are two of the key options. The definition of insolvent is when liabilities total more than the value of assets, and debts cannot be paid. Insolvent trading is where a business continues to incur debts even though the owner or directors are aware, or should be, that the business cannot pay them. A business’s principals in these cases can be held personally liable, and even face jail time in the most extreme cases.
Voluntary administration can be a way for businesses in financial distress to get some wriggle room from creditors. Going into administration could stave off having to go into liquidation if the business is administered in such a way to maximise the chances of it continuing in business (or if that’s impossible, then to at least get a better result for creditors and shareholders upon the inevitable liquidation). The first step is a meeting of directors and appointment of an administrator, who will try to salvage the business’s financial standing.
Apart from a directors’ voluntary administration (where the directors voluntarily make the decision to place the business in an external administrator’s hands), an administration may also be initiated by a secured creditor or the company’s shareholders. The company may also be put into receivership, which is where an external receiver takes over the company’s assets and sells them to pay off secured debt.
If going into administration or receivership does not lead to a viable arrangement, then liquidation is the alternative. Liquidation is the formal process for winding up a company’s financial affairs to settle debts with the proceeds of the sales of its assets. The Australian Securities and Investments Commission (ASIC) has information about insolvency that may be helpful.
A vote of creditors or a court order can put a business into liquidation, or the business can do so voluntarily. The appointed liquidator will prioritise creditors, with secured creditors first (those whose claims against the company are protected by a charge over a specific asset or group of assets – like a bank that issues a mortgage), then unsecured creditors (with contractual rights to receive a set amount of money but not backed by a charge over a specific asset) and lastly shareholders.
Generally, the claims of one priority class must be fully satisfied before those of the next priority level down get to see a cent. There may be pro-rata payments among claimants at the same priority level if not enough funds can be cobbled together. (Note however that the liquidator’s costs are always met.)
The liquidator’s job is to get the best result for creditors and shareholders, and part of this can be collecting, valuing and selling all assets. If any insolvent trading is uncovered, company directors can also be sued by creditors to recoup funds.
But if continuing trading is in everyone’s best interests, then the liquidator can go down that path. Usually however, another outcome of this is to be able to sell the business as a going concern, as well as perhaps to finish and sell work in progress. The aim is to wind up the company, but to do it in a commercially practical way.
Tax consequences – disposal of assets during voluntary administration or liquidation
Of course, as with every other stage of the business life cycle, you will have to factor in the tax consequences of dealing with the business’s financial woes. If assets are sold to pay debts, the proceeds would still be subject to tax as ordinary income or as capital gains. Just be aware that if the business has to sell its trading stock or other assets at bargain prices (below market value), in some instances tax law may nevertheless treat the sale as having been made at market value anyway, regardless of how much was actually received.
If you are a sole trader winding up your business or if you own shares in a company being wound up, and you sell the assets of the business or the shares in the company to a white knight, you will still be subject to tax on the sales. But where the sale is taxed under the CGT rules, you could be entitled to various tax exemptions and concessions under the small business CGT concession rules. In this situation’s best-case scenario, 100% of a capital gain could be tax-free.
If a creditor or a lender decides to forgive part or all of a debt or a loan (that is, releases the business from the obligation of paying the amount back), the amount may fall under the “commercial debt forgiveness” rules. In essence, the business may have to reduce the value of its tax losses (and there may be some if the business has been in strife for a few years), by its capital losses and assets by the amount forgiven. However, the amount would generally not be assessable income, and sometimes there would be no tax consequences at all.
On a related note, if you (or your company) cancel contracts in the course of winding up, there may be capital gains or losses as a result – intangibles such as contractual rights come within the CGT regime.
If you are a shareholder of a company being liquidated, any distribution you receive from the liquidator should be tax-free to the extent that it is a return of your original investment amount; anything above that amount is likely to be taxed as a dividend.
had been imposing penalties as a means of ending a dispute, Noroozi noted that the cost to individuals and businesses of questioning a penalty decision, both financially and emotionally, can stifle their decisions to challenge. Not only that, but the review flagged that taxpayers are required to pay the full or at least 50% of the amount, including penalties, while disputing a decision. He said that while the Tax Office had made some changes to its processes to address such concerns, perceptions of using penalties for settlement leverage have persisted.
The IGT’s recommendations aimed at addressing these perceptions included that the Tax Office:
- only require taxpayers to pay penalty amounts after the dispute on the primary tax is resolved;
- delay discussion with taxpayers concerning any application of potential penalties until after any position papers are issued;
- clearly and concisely communicate to taxpayers the reasons for its ability or inability to reduce penalties and primary tax during settlement negotiations; and
- publish more statistical information on penalties raised and/or adjusted.
- The review also identified opportunities to improve the clarity and practicality of specific aspects of the Tax Office’s penalty guidance, and made recommendations to:
- improve the guidance on voluntary disclosures and penalty remission;
- provide better examples of the law being applied to particular circumstances; and
- consolidate all publicly available penalty materials into a single location.
- Another recommendation from the IGT review was directed to the government, and suggests that it consider whether:
- the current penalties regime could benefit from more categories (to treat taxpayers according to their behaviour);
- penalties are appropriately aligned to factors that influence taxpayer behaviours; and
- taxpayers should be compensated for the time-value of money paid on unsustained penalties.
This last recommendation, that a form of compensation possibly be made available to taxpayers found to be fined in error, prompted a response from the Minister for Finance and Acting Assistant Treasurer Mathias Cormann. The Senator said that given the interaction between the tax penalties regime and the broader system of tax administration, the government will consider this and the other issues raised with the government once its intended “Tax White Paper” process has been finalised. This is expected to commence early in 2015 and continue over the following 18 months to culminate before the next federal election.
Not all of the IGT review’s recommendations have been wholly embraced by the Tax Office, which it explained (perhaps not unexpectedly) as being tied up with what it identifies as “resource constraints”.
Where the heat was felt
An interesting snapshot can be gleaned from the appendices attached to the IGT’s review into the Tax Office’s penalty regime, with data contained therein focusing on the three years surveyed — looking, for example, at both which taxpayers were targeted and the misdemeanours they were fined for. The IGT report found that small and medium-sized businesses tended to bear the brunt of most fines dished out — which over the 2010-11 to 2012-13 income years totalled $4.25 billion.
Of that total, the IGT found that micro businesses (defined as employing between one and five staff) took the biggest hit, being saddled with 51% of total penalties issued, or $1.4 billion in fines. Small to medium sized enterprises (up to 20 employees, or annual turnover of less than $20 million) were penalised $439.2 million for the same period, or a share of 16%.
By comparison, large businesses were issued with $525.9 million (19%) in tax penalties over the three years, and individuals $349.4 million (13%). Not-for-profit groups made up the remaining 1%.
Of the reasons for being issued with a penalty, “failure to take reasonable care” accounted for the most in financial terms, and made up 23% of total fines over the three year period of the IGT’s study. Next came “intentional disregard of taxation law” (17%) followed by “failure to provide document” (14%). The most frequently imposed penalty, but which yields less in total financial terms, was “failure to lodge” (11%), which was imposed roughly three times more than the financially highest-yielding penalty of the Tax Office’s armoury.